Posts Tagged ‘Carbon Tax’

Climate change is hot. From the pope’s encyclical to the upcoming United Nations conference in Paris, leaders are debating how to slow and eventually stop the warming of our planet.

We economists think we have an answer: put a price on carbon dioxide and the other gases driving climate change. When emissions are free, businesses, consumers, and governments pollute without thinking. But put a price on that pollution and watch how clean they become.

That’s the theory. And it’s a good one. But translating it from the economist’s whiteboard to reality is challenging. A carbon price that works well in principle may stumble in practice. A real carbon price will inevitably fall short of the theoretical ideal. Practical design challenges thus deserve close attention.

To help policymakers, analysts, and the public address those challenges, Eric Toder, Lydia Austin, and I have published a new report, “Taxing Carbon: What, Why, and How,” on putting a price on carbon.

Some highlights:

  • Lawmakers could put a price on carbon either by levying a tax or by setting a limit on emissions and allowing trading of emission rights. These approaches have much in common. Politically, however, a carbon tax is on the upswing. Cap and trade failed in 2010, while interest in taxing carbon is growing, including three bills in Congress and endorsements from analysts of diverse ideological stripes.
  • Carbon prices already exist. At least 15 governments tax carbon outright, and more than 25 have emissions trading systems. Those efforts have demonstrated that the economists’ logic holds. If you put a price on carbon, people emit less.
  • Figuring out the appropriate tax rate is hard. The Obama administration estimates that the “social cost of carbon” is currently about $42 per metric ton. But the right figure could easily be double that, or half. That uncertainty is not a reason to not tax carbon. But it does mean we should maintain flexibility to revisit the price as new evidence arrives.
  • Taxing carbon could reduce the need for regulations, tax breaks, and other subsidies that currently encourage cleaner energy. Rolling back those policies, in particular EPA regulations for existing power plants, may make policy sense and will likely be essential to the politics of enacting a carbon tax. But the details matter. Rolling back existing policies makes more sense with a carbon tax that’s high and broad, than with one that’s low and narrow.
  • By itself, a carbon tax would be regressive: low-income families would bear a greater burden, relative to their incomes, than would high-income families. We can reduce that burden, or even reverse it, by recycling some carbon revenue into refundable tax credits or other tax cuts focused on low-income families.
  • By itself, a carbon tax would weaken the overall economy, at least for several decades. That too can be reduced, and perhaps even reversed, by recycling some carbon revenue into offsetting tax cuts, such as to corporate income taxes.
  • Unfortunately, there’s a tradeoff. The most progressive recycling options do the least to help economic growth. And the recycling options that do the most for growth would leave the tax system less progressive.
  • A global agreement on carbon reductions would be preferable to the United States acting alone.  Given the nation’s size and contribution to global emissions, a unilateral tax would make a difference, but would damage the competitiveness of some US industries. Special relief for these sectors could reduce the benefits of the tax, but may be necessary both practically and politically.

A carbon tax won’t be perfect. Done well, however, it could efficiently reduce the emissions that cause climate change and encourage innovation in cleaner technologies. The resulting revenue could finance tax reductions, spending priorities, or deficit reduction—policies that could offset the tax’s distributional and economic burdens, improve the environment, or otherwise lift Americans’ well-being.

The challenge is designing a carbon tax that delivers on that potential. We hope our new report helps elevate what will surely be a heated debate.

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Two great tastes often taste great together. Chocolate and peanut butter. Oreos and milk. Popcorn and butter. Could the same be true of carbon taxes and corporate tax reform? Done right, each could be flavorful. But would they be even tastier together?

My Tax Policy Center colleague Eric Toder and I explore that question in a new paper. We find that using a carbon tax to help pay for corporate tax reform has several attractions and one big drawback. A well-designed tax swap could combat climate change, make our corporate tax system more competitive, and reduce long-term deficits, but would be quite regressive, increasing tax burdens on most Americans while cutting them on those with the highest incomes.

Let’s start with the good news. Putting a price on carbon dioxide and other greenhouse gases would be an efficient way to reduce future emissions, encourage greener technologies, and reduce future risks of climate change. A carbon tax would make real the adage that you should tax things that you don’t want–like pollution–rather than things you do.

A carbon tax could also raise substantial revenue. One common proposal, a $20 per ton tax rising at 5.6 percent annually, would raise north of $1 trillion over ten years. That money could help reduce future deficits, pay for offsetting tax cuts, or a combination of both.

Which brings us to corporate reform. Just about everyone wants to cut America’s corporate tax rate, now the highest in the developed world. President Obama wants to lower the federal rate from 35 percent to 28 percent. Many Republicans, including House Ways and Means Chairman Dave Camp, hope to get down to 25 percent or even lower. But they are all having a hard time finding a way to pay for such rate cuts. It’s easy to talk about closing “loopholes” and “special interest” tax breaks in the abstract, but in practice it’s difficult to cut back enough to make such large rate cuts.

Enter the carbon tax. A reasonable levy could easily pay for cutting the corporate tax rate to 28 percent or even lower. In fact, such rate cuts would require only a fraction of carbon revenues if lawmakers also identify some significant tax breaks to go after. The remaining carbon revenues could then finance deficit reduction or other policies.

Cutting the corporate tax rate would boost the U.S. economy, reduce many distortions in our existing code, and weaken multinationals’ incentives to play accounting games to avoid U.S. taxes. The resulting economic gains might even be enough to offset the economic costs of the carbon tax. That’s a tasty recipe.

Except for one missing ingredient: fairness. Like other consumption taxes, a carbon tax would fall disproportionately on low-income families. Cutting corporate income taxes, on the other hand, would disproportionately benefit those with higher incomes. A carbon-for-corporate tax swap would thus be quite regressive.

Eric and I used TPC’s tax model to measure this regressivity for a stylized carbon tax that would raise revenues equal to 1 percent of American’s pre-tax income. As illustrated by the light blue bars in the chart below, that carbon tax would boost taxes by more than 1 percent of pre-tax income for households in the bottom four income quintiles—1.8 percent, for example, in the lowest fifth of the income distribution. The increase would be smaller at higher incomes. Folks with the highest incomes would bear a significantly lower relative burden—just 0.75 percent of their pre-tax income, for the top 20 percent of households.


Pairing a carbon tax with an offsetting cut in corporate taxes would make things more regressive (dark blue bars). Lower corporate rates would benefit taxpayers at all income levels, workers and investors alike. But the biggest savings would go to high-income households. Cutting corporate taxes offsets less than a third of carbon tax burden for households in the first three income quintiles, but more than offsets the carbon tax burden in the highest-income group. The net effect would be a tax cut for high-income taxpayers, and tax increases for everyone else.

That regressivity is a serious concern. A carbon-for-corporate tax swap may be a recipe for environmental and economic improvement, but it isn’t a complete one. As Eric and I discuss in the paper, lawmakers should therefore consider other policy ingredients—per capita credits, for example—that could help protect low-income households and potentially make a carbon-for-corporate tax swap a more balanced policy option.

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Tom Toles - Carbon Tax - December 2012

Artist/Source: Tom Toles at Go Comics

h/t: Greg Mankiw, A Cartoon for the Pigou Club

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